One of the primary benefits that motivate real estate investors to own rental properties is the cash flow they provide. And having income from rental houses is undoubtedly a significant step toward financial freedom.
But how much will one rental property affect your finances? Probably not much, right?
That’s the predicament many new landlords find themselves in. They save up a large sum of money, find a property to buy, and then deflate their bank account on the down payment.
Unfortunately, most lenders that will fund the purchase of an investment property require at least 20% of the purchase price as a down payment.
Even with a large portion of your income going toward saving up to buy another rental house, it could take over a year to be ready to make another down payment.
Wouldn’t it be nice if there was a way to get around this down payment requirement? Fortunately, there are multiple ways to buy rentals with less money down! It just takes a little bit of knowledge and creativity.
Investors use several strategies to limit the amount of their own money they have invested in each deal. This article will give you an overview of each one so that you can begin building your rental portfolio much quicker!
Why Should You Buy Properties With Less Money Down?
Beyond the ability to acquire more properties in the same amount of time, the most significant benefit of buying rental houses with less money down is an increased rate of return. As an investor, your main goal is to grow your money in the most efficient way possible. A key metric for this is your Cash-on-Cash Return (COCR). COCR is calculated by dividing your annual net income by the amount of money you have invested.
As you can see, the less of your own money you have in a deal, the higher your rate of return becomes. Savvy investors have perfected the art of using other people’s money whenever possible to maximize their return rates.
Using the BRRRR Method to Pull Your Equity Out
The most common strategy that investors use to limit the amount of money they have invested into a rental property is the BRRRR method. This stands for Buy, Renovate, Rent, Refinance, and Repeat. The goal of the BRRRR method is to buy the property at a price that allows you to renovate it and then refinance it based on the new value and pull all or most of your invested money out. This process generally works well for houses that can be improved to increase their value.
Here is a breakdown of a deal that the BRRRR method would work great for:
- Purchase Price: $90,000
- Repairs Required: $35,000
- After Repair Value: $160,000
- Rent Value: $1,300/month
- Refinance Loan Amount: $150,000 x 80% = $120,000
- Cash Left in Deal: $90,000 + $35,000 + $5,000 (closing costs) – $120,000 = $10,000
- Monthly Payment (Including Taxes & Insurance): $823
- Total Net Operating Income (After Prop. Mgmt. & Maint.): $217/month
- COCR: 12 x $217 / $10,000 = 26%
As you can see, the BRRRR method allows you to generate significant returns. Compare the deal above to one where you bought the same house, but it had already been fixed up, and the purchase price was $150,000. The monthly income numbers would be the same, but you would have over $30,000 invested instead of only $10,000.
With this strategy, it is possible to find a killer deal where you can actually get paid a profit from the refinance proceeds!
Most lenders will allow you to refinance an investment property at either 75% or 80% of the After Repair Value, so you cannot pull all of the equity out. This is a good thing because you do not want to abuse this strategy and become over-leveraged.
Minimize Your Down Payment Using Owner Financing
What if you didn’t even have to use a lender to purchase a rental house? And no, we don’t mean buying it in cash! We mean letting the seller be the bank by using owner financing.
It is totally possible to purchase a house and have the owner finance a portion of it. And this doesn’t mean that the seller has to produce this amount of money. It just means that you will make monthly payments to them based on the principal amount and the interest rate, just like you would a traditional lender.
Here are some of the most common forms of owner financing:
The simplest form of owner financing is called a seller take-back. This generally occurs when the seller owns the house free-and-clear without any mortgages on it. In this case, the monthly payments you make to them go straight into their pocket.
With this deal structure, you will typically agree to a sales price, a down payment amount, interest rate, amortization term, and sometimes a balloon term. The balloon term has to do with how long you will go before paying off the remainder of the loan in a lump sum. Most sellers will not want to leave this newly created loan in place for thirty years, so a balloon term of three to five years is often a good compromise. You can typically pay off the balance by selling or refinancing the house.
This deal structure is very similar to the seller take-back strategy outlined above. The primary difference is that, in this case, the owner still has a loan on the property. Even in this scenario, It is still possible to buy the house using owner financing.
In effect, the new loan created between you and the seller “wraps around” the existing loan. All this means is that the balance and monthly payment of the new loan are generally greater than these amounts on the original loan. When you make your payment to the seller, the first portion goes toward paying their mortgage payment, and the remainder goes to them. The same thing happens when you pay off the balance. Their original loan is paid off first, and they keep the rest.
The terms involved with a wrap-around mortgage will be the same as those outlined for the seller take-back. In many cases, it will make sense for you to pay the seller’s lender directly and give them a check for the difference. That way, you ensure that the underlying loan is being paid.
Buying Subject to the Existing Financing
Sometimes, a seller is in a position where it makes sense for you to just take over their loan balance and monthly payment, which is called buying the house subject to the existing financing. This is very common among homeowners that are facing foreclosure. Instead of the house going to auction and their credit being destroyed, you can make up the back payments and then resume making monthly payments on the property.
This approach can be structured in a way that works for everyone. Instead of only taking over their balance, you can additionally give the seller a sum of money at closing. This can often help them with moving costs or other expenses in their life.
Creative Financing Strategies Can Transform Your Rental Portfolio!
If you implement the strategies mentioned in this article, your rental business can benefit in several ways. First off, you will be able to spread your capital further and add more properties to your portfolio. Secondly, minimizing your cash invested in deals will cause your rate of return to skyrocket! And lastly, utilizing the owner financing strategies listed here can often allow you to buy houses that you wouldn’t normally be able to buy using traditional financing methods.
Every property that you add to your portfolio will add to your cash flow and get you that much closer to your financial goals. However, rental properties don’t run themselves, so you must have a system in place to manage applications, tenant screening, payments, and maintenance. But if you combine these creative strategies with a robust property management tool, you will go from being an average landlord to a real estate mogul in no time!
Jordan Fulmer is the owner of Momentum Property Solutions, a house buying company in Huntsville, AL. They specialize in buying houses in tough situations and renovating them to either sell or rent. Jordan also runs the SEO side of their business and regularly writes content about real estate investing, home improvement, SEO, and general real estate topics.